What are balloon payments?
Balloon payments are a feature of a loan structure where the borrower pays off a large portion of the loan in one lump sum at the end of the loan term. This payment is typically much larger than the regular monthly (or weekly) payments, and is often referred to as the “balloon payment” because of its size. You may also hear it referred to as a “balloon loan” or a “balloon mortgage”. Balloon payments are commonly used in car loans, mortgage loans, and many other types of financing. Knowing what balloon payments are and how they impact your overall loan structure is an important concept to understand when seeking finance.
So “What is a balloon payment on a car?” specifically you may be asking.
A balloon payment on a car is a large, lump-sum payment that is due at the end of vehicle finance loans. The idea behind a balloon payment is that you make smaller monthly payments over the course of the loan, and then pay off the remaining balance in one large payment at the conclusion of the loan term. Having reduced monthly payments can be especially helpful for people who have a tight budget or who may be unable to qualify for a traditional car loan.
Risks of choosing balloon payments
However, it’s important to understand not only what a balloon payment is, but also the potential risks of incorporating this feature into your loan structure.
The most significant risk of a balloon payment is that the borrower does not have the money available to pay off the large, lump-sum payment at the end of the loan term. If this happens, the borrower could lose their car or be required to take out another loan to cover the balloon payment.
Secondly, because the borrower is paying off a smaller portion of the loan each month, the overall cost of the loan may be higher. This is because the borrower will be paying interest a higher remaining balance of the loan for a longer period, resulting in more total interest being paid over the life of the loan.
“What is a balloon payment example?” I hear you say.
Let’s say a borrower takes out a 4-year car loan for $20,000 with a 5.99% fixed interest rate over the term loan. The monthly repayments are $469.61, with no balloon payment required at the end. After making 48 monthly payments of $469.91, resulting in a total of $22,541 paid, the borrower has no more to pay, and they own the car. The interest paid on the car loan is $2,541.
Now let’s say the borrower wants to keep the monthly repayments under $400. To achieve the lower repayment, a 20% balloon payment of $4,000 is added to the loan structure. This reduces the monthly repayments to $395.65, saving $73.96. After making 48 monthly payments of $395.65, the borrower will be required to make one additional lump-sum payment of $4,000. This will result in a total loan cost of $22,991. The interest paid on the car loan is $2,991.
Are balloon payments right for you?
Remember, that whilst balloon payments can be helpful in reducing your loan repayments, it is important to note that balloon payments are not for everyone. They are a useful option for borrowers who are on a tight budget and need lower monthly repayments, but borrowers should carefully consider their financial situation and the potential risks before agreeing to a loan with a balloon payment.
We hope to have successfully answered your question of “what is a balloon payment on a car”. If you’re still looking for more information contact one of Fido Finance’s qualified and reliable car finance brokers by visiting us online or calling the team at 13 34 36.
